Prior to the economic downturn, purchasing property to renovate and sell was an upward trend. In the property boom, people with no experience in developments would purchase a property, renovate or redevelop and sell for a sizeable profit.
Many times a profit was achieved not because of the superior quality of work but mainly because these developers caught the residential boom at the right time. However, the market changed quickly and the encumbering effects of the economic downturn directly impacted investor sentiment and bank lending requirements. These factors, together with the increase in building costs, have led to a sharp decline in “buy-renovate-sell” investors.
Investors wanting to purchase property to renovate and sell are finding it increasingly challenging to secure the required funding as a result of the cautious approach adopted by banks in both the local and global economic sectors.
According to Gary Palmer, CEO of leading asset-based lenders Paragon Lending Solutions, there has been more than a 50% decrease in the number of applications relating to “buy-renovate-sell” over the past two years.
“The growing disinclination by banks to finance these types of deals is driving several investors to asset-based lenders, who are providing the necessary funding to enable these deals to reach execution.”
Palmer asserts that, despite this marked deceleration, there are still opportunities for experienced investors and developers to unlock substantial value within the sector, provided investors thoroughly conduct their research and project feasibility.
“With the hampering effects of the economic downturn, residential property prices have substantially decreased, creating opportunities for investors to purchase un-renovated residential properties at affordable prices. If experienced investors purchase a property at a reasonable price and contain the building costs, there will be sizeable room for profit in the 'buy-renovate-sell' market”, adds Palmer.
He maintains that the reason banks are reluctant to fund such deals is due to their short-term nature. An additional reason for this is that banks would require a pre-sale before they look at advancing the money, and, in most cases, investors will only want to put the property on the market once it has been completed.
“Reliable asset-based lenders are becoming increasingly sought after by investors because they take a view on the value of an asset as well as the finished product. Closely aligned with global markets, second-tier lending in SA has become vital for property investors who have been incapable of attaining financing through traditional channels.”
Palmer also alerts investors to the regulations which need to be complied with when re-developing a residential property. One such regulation is the National Home Builders Registration Council (NHBRC).
“We have seen many situations where investors have started a development and are seeking funding but have not realised that NHBRC is required for the development. The cost to register with the NHBRC and enrol the properties can be very expensive and this cost needs to be factored into the development.”
He argues that another reason for the dwindling number of people purchasing property to renovate and sell is due to the increase in building costs over the past few years.
“Within the current market, much of the profit in the deal relates to the cost of renovation or development. High building costs have deterred investors from renovating to sell and rising commodity prices and labour costs have made it difficult to bring new homes onto the market at affordable prices.”
With residential property prices declining over the past two years, astute investors are able to purchase properties relatively cheaply within the current market.
However, Palmer warns that investors need to factor in the cost and feasibility of holding the property, because it is taking longer to sell properties in the market in comparison with two years ago.
The average sales cycle of residential property has gone from a previous 15 weeks and six days to 19 weeks and one day, in the first quarter of this year, according to an FNB estate agent survey. This is becoming more important as interest rates are expected to increase in the last quarter of this year.
According to Palmer, typical clients approaching Paragon Lending Solutions include builders who have purchased the underlying property many years ago or where the property was purchased relatively cheaply and the builder can keep building costs down.
Palmer believes that the emergence of second-tier lenders onto the market will significantly revive the ailing buy-renovate-sell sector, which possesses lucrative value, provided the necessary funding is secured.
“The rigorous bank lending criteria is inciting a surge of interest within the short-term asset-based lending industry, and we anticipate this interest to persist within coming months.” - I-Net Bridge